Linneman: Excess supply may prolong multifamily industry’s woes

The multifamily sector will return to "normal levels of demand" by December of 2003, but vacancies will continue to creep up as new supply comes on line. That’s the mixed forecast Economist Peter Linneman gave industry professionals Thursday at the National Multi Housing Council’s annual meeting in La Quinta, Calif.

"This sector needs to hold off on introducing new product for nine to 10 months," said Linneman, who is the professor of real estate, finance and public policy at The University of Pennsylvania’s Wharton School of Business. "If you are building apartments, stop!"

According to Linneman, it will take approximately three years for the economy to cycle through its current slump. Although the rate of multifamily construction has dropped by 35% nationally, developers are continuing to add as much as 5% to 11% to the stock in many markets. Due to the additional supply, apartment vacancies — which currently stand at 6.5%, according to Encino, Calif.-based Marcus & Millichap — will rise to nearly 7% before leveling off toward the end of the year.

But Linneman told developers and investors not to panic at the rising vacancies. He noted that burning off excess supply is a natural part of the recovery process. "The situation with the economy is that people forget what a recovery is like," said the economist, who founded the Wharton Real Estate Department. "Everybody has broken a bone, had surgery, recovered from the flu. In recovery, you have a period that was really bad. And the reason it was called recovery is because you’re not back to normal yet."

Adding to the woes of the cyclical economic decline is the dramatic drop in interest rates, which have funneled would-be renters into home ownership. The 10-year Treasury Yield continues to hover around 4%. The key is to be patient and ride out this period of weak demand, he advised. Linneman noted that multifamily demand will pick up over the next few years as Echo Boomers, the children of the Baby Boomers, begin hunting for apartments.

Many Echo Boomers are in their early 20s, the prime renting years. The key, Linneman said, is to adjust apartment offerings to fit the needs of this thrifty group. "Not many are going to want to rent $3,000 apartments," he said. "That’s not where they’re at."

So as demographic trends promise an increase in renter demand, there is a light at the end of the tunnel, Linneman stressed, and it will only get brighter if multifamily developers and owners practice some self-restraint. "Just go out and whack around some golf balls and not build anything for 10 months," he advises. "When you get done whacking around golf balls, things will start to look better."